The use of social media as the tool that makes crowdfunding work has made securities law people very nervous. After all, underlying the success of Kickstarter and Indiegogo is a social phenomenon – campaigns that are effectively promoted are the ones that are successful. The securities regulators’ concern is that people won’t take the time necessary to personally vet potential investments and will have an over-reliance on social media messages rather than financial facts. Of course all this hand wringing will ultimately prove unnecessary, since the primary flow of investment capital for equity crowdfunding campaigns will likely mirror that of their rewards-based brethren. A vast majority of the money will come from people who have a direct connection to the company (or its founders) and people who have a direct connection to those initial investors. Although there are certainly going to be exceptions to this pattern – there are already exceptions that can be pointed to in reward crowdfunding – the vast majority of investors will be tier one or tier two connections with the company. As the JOBS Act flounders without final rules that may unleash its promise of equity crowdfunding, more and more states are passing laws (or promulgating administrative rules) to allow crowdfunding. The way that federal securities laws are structured, the states have the ability to carve out their own exemptions only if the campaigns are conducted within state lines. And these intrastate crowdfunding rules generally stand in stark contrast to the complex JOBS Act requirements. The state approach is much more simple and cheap. But there has been worry that use of the Internet (a key component to make crowdfunding successful) will get companies in trouble – since information about their offering will necessarily be seen by people from other states. On April 10, 2014, the SEC issued some C&DIs to help us understand how companies using intrastate exemptions could conduct themselves to communicate their offerings. By the way, C&DI means “Compliance and Disclosure Interpretations”. Normal people call these “FAQs”. Question 141.03 Question: If an issuer plans to conduct an intrastate offering pursuant to the Section 3(a)(11) exemption, may the issuer engage in general advertising or a general solicitation? Answer: Securities Act Rule 147 does not prohibit general advertising or general solicitation. Any such general advertising or solicitation, however, must be conducted in a manner consistent with the requirement that offers made in reliance on Section 3(a)(1) and Rule 147 be made only to persons resident within the state or territory in which the issuer is a resident. ENGLISH: You can advertise an intrastate crowdfunding offering – BUT only in a way that makes it likely that the potential investor is actually in your state. Of course, it makes practical sense anyway since you don’t want to deal with a bunch of inquiries from out-of-state people who aren’t allowed to invest anyway. Because you can geo-target Internet advertising through networks or Google, a company promoting its offer online should have the ad display exclusively in its home state. But how about using social networks? Question 141.05 Question: Can an issuer use its own website or social media presence to offer securities in a manner consistent with Rule 147? Answer: Issuers generally use their websites and social media presence to advertise their market presence in a broad, indiscriminate manner. Although whether a particular communication is an “offer” of securities will depend on all of the facts and circumstances, using such established Internet presence to convey information about specific investment opportunities would likely involve offers to residents outside the particular state in which the issuer did business. ENGLISH: The SEC really doesn’t want companies blasting their intrastate offering across the Internet. However, I think it is reasonable to use social networks to indicate that there is an investment opportunity available to residents of a particular state, BUT that the Tweet is NOT an offer of securities. So how do that in 140 characters or less? “GA residents only: Learn more about investing in Jon’s Jewels? This ain’t an offer. For that, go to sparkmarket.com.” Combined with additional guidance recently provided by the SEC respecting social media, I do not believe that full, lengthy disclaimers are required when the communication made on Twitter (or Facebook) is designed to direct someone to more complete information. So once an investor gets to a website, are they allowed to see all the various securities offerings or just the ones for their own state? Question 141.04 Question: An issuer plans to use a third-party Internet portal to promote an offering to residents of a single state in accordance with a state statute or regulation intended to enable securities crowdfunding within that state. Assuming the issuer met the other conditions of Rule 147, could it rely on Rule 147 for an exemption from Securities Act registration for the offering, or would use of an Internet portal necessarily entail making offers to persons outside the relevant state or territory? Answer: Use of the Internet would not be incompatible with a claim of exemption under Rule 147 if the portal implements adequate measures so that offers of securities are made only to persons resident in the relevant state or territory. In the context of an offering conducted in accordance with state crowdfunding requirements, such measures would include, at a minimum, disclaimers and restrictive legends making it clear that the offering is limited to residents of the relevant state under applicable law, and limited access to information about specific investment opportunities to persons who confirm they are residents of the relevant state (for example, by providing a representation as to residence or in-state resident information, such as a zip code or residence address). Of course, any issuer seeking to rely on Rule 147 for the offering also would have to meet all the other conditions of Rule 147. ENGLISH: Under the JOBS Act, there will be a new type of intermediary called a “funding portal” which requires FINRA registration and compliance with a bunch of rules. But in a state with its own exemption (Georgia, for example) there is no requirement that a company must use a third-party portal for crowdfunding (although they do exist in Georgia – they just aren’t separately regulated). It is not clear that the SEC understands that some companies may use their own website for intrastate offerings. But no matter how a company raises money online, either through their own website or a portal, there needs to be a gatekeeper function. That means that out-of-state investors should not be able to see the offering. Frankly, I don’t think this is a very difficult task. Basically, an online visitor should be required to put their zip code in, and if it is located in the state, they can review the offering materials. If it doesn’t match, they can’t see the materials. Once someone makes the decision to invest, there will need to be an enhanced residency check to ensure that the person is actually in-state. However, the SEC’s guidance is encouraging, because it lets a company or portal “take the word” of the prospective investor to simply review the offering materials. Previous to this guidance, it would have been safer to require a prospective investor register all their information on a site being seeing any offers. And let’s face it, people hate going through a registration process just to browse. The simple requirement to enter a zip code is quick and easy. By the way, none of this is legal advice. These are just some thoughts about how issuers and promoters need to consider the SECs reaction to the emerging use of social media to communicate their securities offerings. Time will tell what the “safe” formula is to balance the SEC’s interest in having lots of disclaimer and disclosure and the social media requirement to KISS (keep it simple, stupid). * A special thank you to Charles Vaughn, Esq. of Nelson Mullins Riley & Scarborough LLP in Atlanta, GA for his thoughts regarding the SEC’s rule interpretations. His extensive securities law experience is incredibly helpful when discussing an emerging regulatory area like that surrounding crowdfunding. And, most importantly, he has been generous with his friendship as well. —————————————————————————-
Jonathan Frutkin is CEO of Cricca Funding, LLC. He’s the author of “Equity Crowdfunding: Transforming Customers into Loyal Owners” which is available in paperback, Kindle and audio book formats.